What are investors buying? Inside the top 20 index funds and ETFs

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In this episode, the focus is on the funds that are most popular among investors looking to track the ups and downs of a particular market, theme, or investment type. Kyle is joined by Dave Baxter to discuss the key trends among the top 20 most-purchased index funds and exchange-traded funds (ETFs) so far this year among interactive investor customers. The duo also look at a recently launched global ETF from Vanguard and explain why it’s important to examine how an index fund or ETF achieves its exposure, as this can differ between funds even when they track the same market. 

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello and welcome to our latest episode of On the Money, the weekly show that covers investment and pension topics in a practical manner.

Today, the focus is on a fund type that has grown massively in popularity over the past decade, and is particularly popular with younger investors, and that is index funds and exchange-traded funds (ETFs).

Joining me to run through this topic is Dave Baxter, senior fund content specialist at interactive investor. Dave, welcome back to the podcast. 

Dave Baxter, senior fund content specialist at interactive investor: Thank you for having me on. 

Kyle Caldwell: Today we’re going to mainly focus on the most popular index funds and ETFs among our own customers. 

I’ve produced essentially a little league table of the top 20 since the start of the year to around mid-September, and that is based on real-time buys, which excludes regular investing. We’ll show the table a couple of times. So, if you’re watching the podcast on either YouTube or Spotify, you will see it there.

But before we show the table, Dave, could you explain why index funds and ETFs have become more popular over the past decade? 

Dave Baxter: So, I’m going to give three reasons. One is simplicity. There is a simple premise behind buying these funds. You buy the markets and it’s quite easy to understand. The second is fees. So, there’s been a big price war in this space. The fees, as we’ll discuss, are very low. I think that’s instinctively appealing even to someone who doesn’t really know about investing.

And probably the biggest reason is performance. Passive funds markets generally have done very well. Active funds have been pretty inconsistent in getting the better of those markets. And I think over the last decade in particular that narrative has picked up and a lot of people have subscribed to this mantra of ‘just buy a tracker’. 

Kyle Caldwell: I completely agree with all those points, Dave.

Just to slightly extend one of your points. I also think investors like index funds and ETFs because they broadly know that they’re going to get what it says on the tin; the performance of a particular index minus, in most cases, the very small fee that the index fund or the ETF charges.

On fees, if you’re seeking to gain exposure to the global stock market, the UK, or the US, then typically you can find index funds or ETFs that charge less than 0.2% a year or less than 0.15% a year. So, on a £10,000 investment, that’s £20 or £15, which is very compelling because you’re getting lots of exposure to different companies, sectors and industries. We’re talking hundreds or thousands of companies in the case of a global index fund or ETF.

Whereas with an actively managed fund managed by a professional investor, first, you don’t know at the outset whether the fund manager is going to outperform. 

Second, the charge that they levy is higher. It’s typically 0.8-0.9% a year. 

Going back to my point, I think people like the simplicity of knowing from the outset, ‘that’s broadly what I’m going to get’, and people [will] happily take the return of a particular index.

Dave Baxter: Yeah. Again, I think it’s that idea, isn’t it, of ‘just buy the market and you should in theory see things go up’. I mean, people do warn that because of the composition of trackers, because they’re very concentrated around a handful of names, things could go south. So, it is worth bearing in mind, but in the last decade that whole kind of appeal has been there. 

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Kyle Caldwell: I think it’s important to point out that it’s not an either/or decision. I invest in both actively managed funds and index funds and ETFs (so-called passive funds) in my own stocks and shares ISA, and in my pension, I mix and match between the two strategies.

But when it comes to actively managed funds, I’m really trying to ensure that the fund manager is doing something vastly different from what I can get elsewhere from an index fund or an ETF for a much lower fee. 

So, now that we’ve explained the popularity of both index funds and ETFs, let’s look at the ones capturing the investors’ attention.

If you’re watching the podcast on YouTube or Spotify, you’ll now see the top 20 table. Dave, standing out like a sore thumb is the sheer amount of global strategies in this top 20.

Now, global ETFs and index funds can make great core holdings for investors. Could you explain why? And are there any other reasons why you think this fund type is particularly popular? 

Dave Baxter: Yeah, I mean, it makes a good core holding because in theory it gives you diversified exposure to the main markets. Interestingly, I suppose trackers also are effectively backing the kind of winning shares and the winning regions of a given market. So, you are kind of capturing those returns, and then you can add so-called satellite holdings alongside that. 

Looking at the popular names, we have got those global funds. What’s interesting is a lot of the popular ones have the ‘All World’ phrasing in their names and the important distinction between, say, a FTSE World fund and FTSE All World fund is ‘All World’ has a bit of exposure to emerging markets. So, it’s still very US-heavy, but it’s a bit less US- dominated and, in theory, it’s a bit more genuinely global and diversified. 

Kyle Caldwell: For me, Dave, that’s why it’s important to look beyond the ongoing charges figure (OCF) for an index fund or an ETF. On charges, that doesn’t represent the full fee that you’re paying because transaction costs are not included. It’s important to find out those transaction costs as well. In most cases, they are small, particularly if you’re investing in a global index fund or an ETF. But if you’re investing in an index fund or an ETF that’s investing in smaller companies or the emerging markets, transaction costs do tend to be higher than one that’s investing in, say, larger companies in a developed market. So, try and find out the all-in fee because, ultimately, you are paying it. 

Also, in terms of looking at the bonnet, as you mentioned Dave, you need to understand what you’re buying, because while [funds] might appear to be doing the same thing such as investing in global shares, some [funds] will only invest in developed markets and some will give you some exposure to a specific one and emerging markets.

Due to the fact that different index funds and ETFs do different things, the performance gap can be quite different depending on how it is giving you that exposure. 

Dave Baxter: Yeah. There’s the phrase ‘just buy the market’, but you do have to ask yourself, which market am I buying? If you look at regions like the UK or the US, you’re normally fairly safe. So, for example, if you track the S&P 500 or the MSCI USA index, they’re not going to be insanely different, but you do get some of the major equity regions where you can track them in very different ways.

Say, Japan has a handful of different indices and they can be quite different in their make-up. Similarly, in Europe, you get some indices that, for example, would include Switzerland and some that would not. So, you can get a big difference in terms of the big shares you’re exposed to and the broader composition. 

Kyle Caldwell: It’s particularly important to look under the bonnet when it comes to thematic ETFs because the provider is deciding how it’s gaining exposure. Normally, they filter for some sort of revenue requirements. For example, if it’s a robotics ETF, it’ll only invest in companies that are generating a certain percentage of their revenues from robotics. However, the percentage revenue that’s chosen can potentially vary.

I’d also look very carefully under the bonnet when it comes to global equity income index funds or ETFs because there are different ways they go about screening the market. Some will invest in the highest-yielding companies globally. Others [prioritise] dividend growth, and there’s one particular product investing globally that focuses on the companies that have the longest dividend track records. 

Depending on which one you choose, the difference in returns can be quite stark. I’ve run some numbers on this. I used a sample of five index funds or ETFs that give you global equity income exposure. The top performer’s overall returns over five years was 81%, while the one in fifth place in the sample was up 47%. So, that is a pretty sizable difference. 

So, as mentioned, do look at the ongoing charges figure, factor in transaction costs, but also, really importantly, understand how it’s tracking the market. 

Dave Baxter: There’s actually a similar difference - or last time I checked - in the UK if you look at those UK dividend ETFs. There’s one that just targets a high yield and there’s one, I think, from the same franchise you’re mentioning that looks for companies that have at least six or seven years of dividend increases to qualify, and the more cautious one is just way behind because the high-yielding one has had exposure to energy. 

In recent years, you’ve had very strong returns from your BPs, your Shells, and so on, and it’s just made a massive difference to your total returns. 

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Kyle Caldwell: Now, moving back to our top 20 table, I think if we were to do this podcast again, Dave, in a year’s time, I would wager that a recently launched ETF from Vanguard would be in the top 20 table, but it isn’t at the moment because it only launched in late August. It is the Vanguard FTSE Global All-Cap ETF USD Acc GBP (LSE:VALL).

Now, the launch of this fund will pique the interest of investors because it is very cheap. It’s yearly ongoing charges figure is just 0.07%, which makes it the cheapest way to gain an All World approach with that emerging market exposure. 

The reason why this fund was launched is because, firstly, it fills a gap in Vanguard’s range. So, they have the index fund, Vanguard FTSE Global All Cp Idx £ Acc (BD3RZ58), which is in our top 20, but there’s no ETF equivalent - this is a mirror version of that fund. I think it’s really interesting, Dave. That index fund is a lot higher in terms of the fee, which is 0.23%.

What I also find interesting is that the Vanguard FTSE All-World ETF USD Acc GBP (LSE:VWRP), which appears twice in our top 20 - both its accumulation and its income share class - charges 0.14%. But it only recently cut that charge down from 0.19%. That was a month before this new VALL ETF launched. 

While it is early days, and we’re yet to see a meaningful time period in terms of how VALL performs, it does look like it’s going to be very similar to the Vanguard FTSE All-World ETF.  Yet, it has a charge of 0.07% and then the Vanguard FTSE All-World ETF is 0.14%. 

The main difference is VALL is going to give you some exposure to global smaller companies. But, for me, I think the jury’s out in terms of how meaningful that exposure is going to be. Is it going to be significant enough to have an influence on the overall returns? 

Dave Baxter: So, with the usual caveats, if we’re looking at past performance, it seems it doesn’t. 

So, when VALL was launched roughly a month ago, I tried to suss it out because, at the minute, VALL doesn’t disclose what its exposure to small, mid, and large caps is. I tried to suss it out by looking at the performance of the FTSE Global All Cap index and the FTSE All-World index. If you look in past years, then performance is pretty much identical. So, it seems that that small-cap exposure has really not been enough to move the dial. So, hopefully you should just see them continue to perform really pretty similarly. 

Kyle Caldwell: I’ll put my own cards on the table. I actually invest in the Vanguard FTSE All World ETF (VWRP) – the accumulating version. So, like many investors I’m particularly interested in this new VALL ETF, particularly given that it’s cheaper than the one that I own. 

However, I want to wait until I can see how efficiently it has tracked the underlying market, whether it has got a low tracking error, which is the key metric for investors to look at in terms of how closely the index fund or ETF has replicated the underlying market.

As you mentioned, Dave, at the moment, we don’t know what the percentage weighting is to smaller companies. I mean, if I wanted global smaller company exposure, I’d want it to be 10-15%. I’d want it to be a decent part of an index fund or ETF. I wouldn’t want it to be less than 10% because then I’d wonder whether it was really going to make much of a difference to those overall returns.

Dave Baxter: Yeah, I think it’s worth adding that often these trackers that, in theory, cover the entire market are still pretty led, at least in recent years, by large caps. Turning briefly to the UK, if you look at a FTSE All-Share ETF and a FTSE 100 ETF, the performance is not that different, just because those bigger companies are so dominant in the portfolio. 

Kyle Caldwell: I completely agree. You can see in the top 10 holdings for VALL, as you’d expect, that a lot of the big US technology names are there.

We do actually know how many holdings it has at the moment. At the end of August, it was 6,439. So, the index that it’s tracking, the FTSE Global All-Cap Index, has 10,000 companies. So, it has 3,500 companies less than that index. 

However, that’s not unusual because Vanguard, in common with other passive fund providers, samples the index. ‘Sampling’ is actually quite intuitive for a piece of fund jargon, which is not always the case as we both know. They’re sampling the market, so they’re giving you exposure to a subset of the index. 

They do this to keep costs as low as possible, and also because the smaller companies in the index don’t particularly add to the overall returns since they’re too small to make a big enough difference.

So, they’re cutting costs and they’re trying to replicate the market as close as they can with the sample companies that they’ve chosen. They do try and ensure that the sector and country weightings are broadly the same as the overall index because they don’t want to diverge from the index. They want to be as close as possible. 

Dave Baxter: While we’re talking about keeping costs down, and if we’re trying to honestly examine the reasons that you might not go for VALL, one is the so-called bid/ask spread. So, that’s another cost that relates to the trading, liquidity, and that kind of thing. At the minute, the bid/ask spread for VALL is higher than on those more established funds that we’ve mentioned.

However, the spread can tend to come down as the fund grows, as you get more trading, more volume and so on. Even in just one month of its life, VALL has already built up something like $600 million (£452 million) in assets. And if we look at previous examples, when these big trackers cut their fees or new cheap ones launch, they do tend to bring in this massive wave of money. So, you would expect it to develop a decent level of scale and then that spread should come in over time. 

Kyle Caldwell: That’s a great point. Just to reiterate what you said, the bigger the fund gets, you would expect that spread to tighten over time. 

With fund charges, as they’re percentage based, even with a small difference, you might think it’s not going to make a meaningful impact on your wealth over the long term, but it actually can. Just to illustrate that point, you did some number crunching. 

Dave Baxter: Yeah. First, we should credit a great tool we used on the Candid Money website for this. This is fantastic.

So, let’s get into our scenario. I imagined here that you put an initial lump sum of £500 into each of the different kind of funds, or funds with different fees. Then you would deploy a monthly £200 in for 20 years. You’d get an annual return of 5%. If the fee were 0.07%, you’d get nearly £82,200. On 0.14%, you’d get £81,530, and then on the highest fee you get around £80,000. So, that’s still a decent difference.

Obviously, the difference gets higher if you get bigger returns. Also, it’s worth bearing in mind that that gap is going to widen if you continue because you’re getting compounding of returns. So, the more you save in fees, the more money you have to build and build on your existing returns. 

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Kyle Caldwell: The reality is that when it comes to investing, you cannot predict in advance how well an investment is going to fare. But one thing you can control, probably the only thing you can control, is costs. So, it is really important to consider costs and try and keep charges as low as possible. 

In particular with an index fund or an ETF, if it’s giving you exposure to the same index, is tracking the market efficiently, has a low tracking error, and the transaction costs are low, then why would you pay more for the same product elsewhere? 

Dave Baxter: At least with active funds, you can say, ‘Oh, maybe this fund is doing something distinctive.’ But here, you have so many ways in which to get the same exposure. So, just go for the cheapest way. 

Kyle Caldwell: Let’s move on to other trends we’re seeing among the top 20 most popular index funds and ETFs.

In terms of regional exposure, the only one on the list is the iShares Core FTSE 100 ETF GBP Acc GBP (LSE:CUKX). For me, this reflects investors thinking, ‘I’ll just go global. I’ll take whatever the regional exposure is in the global index funds or ETFs’ rather than having to pick particular regions to invest in and build a global portfolio. 

Dave Baxter: This might be a mistake I guess because as we’ve discussed a lot - we’ve already done it today and in many other episodes - global trackers tend to be largely a bet on the US. So, if you think you’re getting enough exposure to those other regions, then you’re not as you are missing some diversification. You’re missing exposure to regions that have done very well but are a bit unloved like Europe and Japan.

Kyle Caldwell: Another trend that we’re seeing is gold, silver, and some technology exposure. These types of index funds or ETFs should really form more of the satellite part of a portfolio rather than the core because they are more adventurous in terms of the way they invest. 

Dave Baxter: Yeah and if I’m going to be harsh, and I am briefly, then you could argue that some of the people buying these are performance chasing. If we were speaking a year ago, gold and silver were on this phenomenal hot run, and then since early on this year, they’ve run into a bit more trouble. So, yeah, you do need to be careful. As you said, you do need maybe smaller positions and you could do things like regular investing to try and even out those ups and downs. 

Kyle Caldwell: I completely agree and it goes back to the point we make very regularly on this podcast about the importance of diversification, particularly with, say, a theme. 

It’s tempting to get involved when you’re seeing lots of companies participating in that theme and doing really well. There’s FOMO if you’ve not made any money from it, but it’s really important to take a step back and remember that those really good returns didn’t go to you, they went to other investors. Are you now entering the market at an opportune time or an appropriate time, and consider the outlook for the theme or commodity going forward, rather than looking back. 

Dave Baxter: Yeah. Ideally, you want to go the other way and be contrarian, buying things that are out of favour, but it’s easy to dismiss that argument in an era that’s been dominated by things like the Magnificent Seven shares going up and up and up.

Kyle Caldwell: So, we’ve run through key trends we’re seeing in the top 20. Which types of index funds or ETFs are investors overlooking that you think warrant a closer inspection? 

Dave Baxter: I have two thoughts on this. One is something we’ve just discussed, which is regional equity ETFs. So, Europe, Japan, even emerging markets. They are included a bit in All Worlds, but emerging markets in the last year have had this amazing rebound. So, if you have more dedicated exposure you could have gotten more out of that. 

One other area is smaller companies. It’s not always that easy, to be fair, to find regional smaller-company trackers but you can find global products, and small caps have lagged behind in recent years. So, in theory, they should offer some diversification to the Mag 7 and so on and, in theory, they might be due a bit of a more extended rebound over time. 

Kyle Caldwell: Just to play devil’s advocate, you mentioned smaller companies, active fund managers in particular do bang the drum for that part of the market because it is less well researched. 

Dave Baxter: Yeah, that’s a very well-rehearsed and valid argument. I think another interesting point to make there is about activism. Active managers can build big stakes in these smaller companies and then say ‘OK, now we want you to do something like a share buyback to enhance returns’, and if you look in the UK, some of those more activist funds there have done well, also in Japan, so you are seeing that paying off to an extent. 

Kyle Caldwell: That’s a great point, Dave, and it goes back to the various points we’ve made throughout the podcast about looking under the bonnet and understanding how the fund manager is investing.

If they take more of, say, an activist investor approach, then you should know that because they should be getting that across in the way they communicate to investors.

Dave, thanks for coming on today.

Dave Baxter: Thanks for having me on. 

Kyle Caldwell: And that’s it for our latest On the Money podcast. As usual, you can find lots of investment and pension articles on the interactive investor website.

If you’ve got a question or a topic you’d like us to cover in a future episode, then please do get in touch by emailing us at: otm@ii.co.uk. We’ll see you again next Thursday.